Inflation talk is expected to dominate the Federal Reserve’s annual summer gathering in Jackson Hole, Wyoming, which kicked off Thursday evening.
Wall Street will be closely watching the Jackson Hole Economic Symposium — which will return to an in-person format after two years of being held virtually — searching for clues about where the Fed might head next in its attempts to tame rising prices.
“It’s interesting how this August speech of the Fed chair at Jackson Hole has become such an important platform for the Fed to influence market expectations about policy. It becomes a self-fulfilling prophecy,” said David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution.
The title of this year’s symposium, which kicks off on Thursday and runs through Saturday, is “Reassessing Constraints on the Economy and Policy.” Inflation is certain to be the hottest, although not the only topic discussed, and nearly every word published or spoken will be painstakingly parsed by traders and analysts for any hint of what it might indicate about the central bank’s policy trajectory.
Of particular interest to market participants is Fed Chair Jerome Powell’s keynote speech on Friday morning.
“[These speeches are] much meatier than the usual policy speech, so there’s much more to chew on,” said Kenneth Kuttner, an economics professor at Williams College.
Wall Street wants reassurance — but not too much
Whether the market will get the feel-good story it wants, or remarks that throw cold water on those hopes, is an open — and hotly debated — question.
“What they are hoping to hear from Jay Powell is that the Fed will move to reduce inflation, but will be sufficiently confident that it can reverse course early next year. I don’t think they’re going to hear that,” said Randall Kroszner, a former Fed governor and deputy dean for executive programs and economics professor at the University of Chicago Booth School of Business.
Instead, he said the Federal Reserve hopes that by raising interest rates quickly it won’t have to raise them too high. “If that’s the case, they may be able to avoid a significant slowdown, but that’s by no means guaranteed,” he said.
The Fed has to thread the needle on policy moves, as well as on how it communicates those intentions. Powell could trigger Wall Street angst if he sounds too hawkish — or not hawkish enough.
“I think what Powell is going to try and do is continue his narrative on fighting inflation while trying to dissuade the market from the notion that the Fed has made a dovish pivot,” said David Norris, partner and head of US credit at TwentyFour Asset Management. “I don’t think he’s going to surprise the markets by his statements,” he said.
“The Fed’s calls to date have been relatively easy,” Wessel said, adding that there isn’t much guesswork involved when interest rates are hovering near zero percent, unemployment is touching five-decade lows and inflation is soaring.
But going forward, weighing the risk-reward trade-offs will become more challenging — and the stakes will become higher — as those initial rate hikes begin to produce economy-cooling results.
“At some point, they’re going to have to decide, ‘Have we done enough?’ and they’re always close calls, and at that point, they will have to decide which risk is most serious — the risk of doing too much and causing a recession or the risk of doing too little and getting inflation embedded in the economy,” Wessel said. “My gut is they’re going to err on the side of doing too much.”
Former Treasury Secretary Lawrence Summers has said the Fed needs to project an aggressive stance on inflation, and is calling for Powell to use his Jackson Hole speech to chart a path of “restrictive” monetary policy. “My worst fear would be that the Fed will continue to be suggesting that it can have it all in terms of low inflation, low unemployment and a healthy economy,” he said on Bloomberg TV over the weekend.
Powell’s words could come back to haunt him
At the Jackson Hole economic summit last year, Powell made the case that inflation wouldn’t linger — a prediction that has not aged well and that economists worried would tarnish the central bank’s credibility.
At the time, he asserted that inflation was confined to a discrete set of goods and services and blamed rising prices on the widespread shift in spending as Americans bought all sorts of goods rather than spending money on services. “From long experience we expect the inflation effects of these increases to be transitory,” he said at the time.
The same day Powell spoke at last year’s symposium, the Commerce Department announced that the Fed’s preferred measure of inflation, the index of personal consumption expenditures, had risen by 4.2% over the year, the steepest increase since January 1991.
“He also spoke at length about inflation and made a lengthy argument that turned out to be… not so good in hindsight,” Kuttner said. “The mistakes are always glaring in hindsight.”
“Maybe this time it’s going to be making a call on the likelihood of a recession,” he said. “I think he almost has to say there won’t be [one]. There’s a good chance he’s going to be wrong on that.”
Kroszner said a similar misstep to the “inflation is transitory” prediction this time around would be if the Fed communicates upbeat sentiment about the labor market that turns out to be unfounded — an outcome he said is likely. Although the current unemployment rate is an ultra-low 3.5%, it would be a mistake to take that for granted, he said, predicting that job losses are likely to rise.
“I think they may be too sanguine about what may happen with the unemployment rate. Even if we don’t have a full-blown recession, I just don’t see how we can have the unemployment rate stay at only around 4% and inflation to come down — and get down to 2% quickly — with an unemployment rate peaking only barely above its long run average,” he said.
It’s possible, Kroszner added, that Powell will adopt the same kind of overly-optimistic outlook that kept the Fed from rolling back its pandemic-era support for the economy even as price increases were picking up.
Supply issues, fiscal policy also likely to be addressed
Fed watchers pointed out that the central bank’s usual tools for combating high prices are limited in the current economy because both demand and supply imbalances are contributing to spiraling prices.
“I think you’ll hear broadly about supply chain disruptions,” Kroszner said, but he expressed skepticism that Fed policymakers fully appreciate the extent to which those disruptions have affected the economy. “We have to take anything positive there with a grain of salt,” he said.
Kroszner said government spending could also be addressed. “My guess is there will be some people thinking about fiscal issues — that’s not directly in the Fed’s control, but the Fed takes [it] into account,” he said.
Even with the trillions of dollars in pandemic-related spending added to the US debt load, paying for it has not weighed heavily on the economy to date, he pointed out — but that dynamic could be at an inflection point, with potentially serious consequences for economic growth in the future.
“Servicing that debt is… going to be a much larger burden, so there might not be as much fiscal space available to respond if there is a significant economic downturn,” he warned.
